We had been advocates for quite some time of extending duration and not just sitting in cash. But now we think that keeping it wherever your benchmark is or a little bit lower makes sense.

By the way, the time of our conversation, just to give people some context, I'm looking at a 10-year treasury yield recently. Well, this is the other day, it was 415. And the shortest thing, like a one-month T-bill, 457. So just a little bit higher on the short stuff. Yeah.

And so, you know, people have been sitting in cash. And then when rates kind of moved up at the intermediate to long end, they started to extend duration, which we were in favor of. But now, given where we are, you don't have a lot of extra premium in there, extra yield in there to go much beyond whatever your benchmark is. So we usually use the aggregate bond index as our benchmark for duration and yield. That's around six years. We would say keep it that level or even a little bit lower. And if we get a rebound in rates going into the year or in the second half of the year, which seems like a probability, reasonable probability, then we would think about extending again. And we also want to stay in higher credit quality bonds. There's not a lot of extra yield in lower quality bonds like high yield bonds to compensate for the risks that you're taking. So the yield difference between a high yield bond and treasuries of comparable maturity is about the lowest it ever gets or even lower than the lowest it usually gets. And that means if something happens in the market that's not good news, you're probably going to underperform with that. Interesting.

Not being adequately rewarded for junk right now. But what about inflation? You have to be a bond strategist. You have to be an inflation strategist. You have to have a view of what's going to happen. Is there anything that you see on the horizon that you think is going to catch people by surprise? What do you expect?

Well, all of these policies are somewhat inflationary, and that's the tariffs. Now, that's more of like a one-time price level increase. If you slap a tariff on something, it's going to go up by that amount or close to that amount and probably get passed through. So if you have a 10% tariff on Christmas toys coming from China, then chances are those prices will be up close to 10% because the company importing them will try to pass that along. So that's one risk. The second risk is that we just don't have as much excess capacity right now for the growth rate that we have. We have a growth rate running around 3% for GDP. That's pretty high relative to what capacity we have to meet those needs. So we'll probably see some just generalized continuing price pressures, but really housing is the one that's critical for most people in keeping inflation up. We do think it'll come down over time, but there isn't a lot of downward pressure now on inflation. It's mostly just upward pressure on inflation.

2.6%. That was the latest inflation rate for the month of October. We're going to hang around 2.6% for a long time, even though maybe the Fed would like to see that moving even lower? are we talking about, you know, we could move from the twos back up to the threes and pushing four or something like that? What do you anticipate?

So, yeah, we don't really look for it to go up a lot. I think, though, that there are areas where it's not going to come down and there are some vulnerabilities. Besides the tariffs, you know, immigration reform could affect certain sectors of the economy more than others, like construction, agriculture, and housing prices are already very high. It's already very expensive to build. So if you get a big decline in the number of people in that construction area, or you have to replace them with more expensive workers or search more widely to find those workers, or simply can produce as much because you don't have the workers, then that's going to push either some wages up or the cost of producing up. And that is something to watch for. So I would look at, you know, unfortunately it's in areas that are very important to people that have been very difficult for people, food and housing. And those are pretty crucial. That

housing is a real tough one. I feel for, you know, young families out there that have been shopping forever and they can't find something affordable. And they're probably watching that mortgage rate all the time, wondering when it's going to come down. What would you tell them? What do you think is on the horizon for the mortgage rate?

I think it'll come down a bit because we will get a few Fed rate cuts. I think we get one at the meeting in December and then they pause, maybe skip a couple of meetings and get a couple more in 2025. So that should bring it down some and make housing more affordable. It's not going to go back to the we're not going to see those 3% mortgages again anytime soon, but we should be able to get south of 6%, which will help the housing affordability to some extent. Now,

you focus on bond strategy at Schwab, and your colleague, Lizanne Saunders, does stock strategy. But when it comes to the subject of people wondering, hey, the stock market's run up so far. Is it time to take money out of stock? Should I put more money into bonds? How do you figure that out? Is it arm wrestling? Do you two arm wrestle to figure out what the allocation should be? Who's in charge of figuring that out? And what would you tell people now?

Yeah, we don't arm wrestle, but we do have a lot of conversations. Probably better

that way.

Yeah, it's probably better that way. I don't know that either one of us would be very good at arm wrestling these days. You know, we do have a lot of, along with all of our other colleagues at the Schwab Center for Financial Research, we have a lot of meetings, a lot of conversations about how best to allocate. I think that right now, Lizanne is certainly seeing risks in the equity market, the narrowness of some of the gains, the valuations being very high. She's always quick to point out that valuation isn't a good trading strategy. Things can stay under and overvalued for long periods of time. I'm seeing the same thing in fixed income markets. When you look at credit spreads, that is the yield spread between, say, corporate bonds and treasuries of comparable maturity, those are very, very low, historically low. And that's a valuation measure that tells you things are pretty highly valued. have people jumping from heavy overweight to equities, overweight to bonds, but to kind of stay with a plan that they might have, an allocation that they've already determined through their financial plan that works for them. So if you're a 60-40 investor, you may not have to change that. You may change under the surface, though, what's in that 40% or what's in that 60%. So if you're a 60-40 investor and you have 40% in bonds, our suggestion is if you are very heavy on high yield or emerging markets or some of the other riskier parts of the market, you might want to dial that back a little bit and focus on the higher credit quality. similar story in the equity market. You may want to shift around your allocation within the equity market to be less exposed to, say, overvalued equities. Is

there something that explains on a big picture level, you know, a societal or demographic level? You mentioned that stocks look pricey and in some respects that bonds look pricey too. And people are used to thinking about financial markets as, well, if this is expensive over here, I'll buy over here where it's cheap. But we go through these periods sometime where just everything seems expensive. What explains that? Is that a glut of people saving at the same time? Or is there a demographic factor that explains that? And for someone looking ahead for like 20 years until retirement, do they have to be worried about any kind of change in that?

Well, I think it's a combination of things. When everything gets overvalued, sometimes it's because policies have been in place that have allowed that to happen, right? And we knew that before the great financial crisis, everything was just going crazy on the upside because you could borrow easily and financial conditions were easy. There's some similarity now, although it's not nearly as extreme. Maybe this is more like the late 90s where we got the economy running at a pretty good rate. So corporate profits are doing well. And there's a lot of money in savings. There's a lot of investors who have gains or who are saving. People have jobs. That means they often have a 401k or an IRA and they're putting money away. And that money has to go somewhere. And it goes to where the most attractive returns have been. And I think that that encourages the longer they keep going, the more people want to be in those investments that have performed well. And you can see that largely by the outperformance of the U.S. versus the rest of the world. You know, U.S. economy is doing better, more attractive markets. That just draws in a lot of foreign capital as well as domestic capital. Something would have to change for that. Either financial conditions would have to get really tight, which doesn't seem very likely with the Fed looking to cut rates, or we get some sort of negative economic news that changes the outlook. And eventually, kind of a string gets pulled as far as it can go, and you get some sort of correction. But it doesn't seem like that's a huge risk right now. Just we just we're in this wave. There's a lot of demand for yield, certainly in a fixed income market. And part of that's demographic, but also returns have been good. So people continue to do what works. We've

talked about bond quality, bond duration, mortgage rates. We touched on surfing earlier. Is there what am I missing here that you're seeing that you think investors should be paying more attention to this thing or something that they're getting or doing wrong right now?

Yeah, I think there's a tendency. We've gone from a tendency to sit in too much cash to a tendency to chase yield wherever it is, because we've had these kind of good returns now. And I would emphasize to people that right now, everything looks pretty rosy. Everybody's optimistic. And that's usually when something changes, right? When something comes along to change it. And then the other thing I would add in the fixed income market is liquidity. People don't focus maybe enough on making sure they have access to their money when they need it. So there's a lot of investments out there right now that provide much higher income streams or returns look very positive or they have looked positive over the last decade or so. And people are kind of looking at this and saying, oh, that looks fantastic. But a lot of them are not as liquid, meaning you can't access your money as quickly and easily as you might like. And that's something to really keep an eye out for.

Thank you, Kathy. There have been some new developments since my conversation with Kathy. November inflation accelerated as expected to 2.7%. The Fed cut interest rates as expected, but it was described as a hawkish cut. Fed members raised their inflation projections for next year and reined in their rate cut expectations. The 10-year Treasury yield has risen to around 4.5% and the one-month Treasury yield has fallen to.3 percent. In other words, the yield curve is un-inverting. Thank you, Kathy. I'd also like to thank all the folks who helped out earlier in this episode with the quantum computing explanation, the Coen brothers, Schrodinger, the cat, the guy from Google who was talking about that Qubit stuff, and whoever wrote that IBM blog. And most of all, thank you, Remy, for sending in the great question. And thanks to all of you for listening. Jackson Cantrell is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, go ahead and write us a review. Merry Christmas if you're Christmasing and see you all next week.